Emanuel: Too late to recoup potential losses on CPS bonds

Mayor Emanuel scoffs at the idea that CPS can do anything about bad bonds, even though other government units

Mayor Rahm Emanuel said Wednesday that it's too late to try to recoup any of the money from burdensome interest payments that Chicago Public Schools made after issuing risky auction-rate bonds.

"There's a thing called a contract," he said.

Other municipal borrowers have sought recourse for auction-rate deals in state court. A suit by a New Jersey student loan agency is awaiting trial in that state.

A Tribune analysis published this week found that CPS' 2003-07 issuance of $1 billion in risky auction-rate debt paired with interest-rate swaps will likely cost the district $100 million more than traditional fixed-rate bonds would have.

Records show that in August 2007 — about three weeks before Bank of America inked a deal with CPS on its final auction-rate bond — a BofA senior official warned internally of a potential "meltdown" in the auction-rate market. School officials said they never got that warning.

When asked Wednesday about that deal, Emanuel said "this is a debate that's about 10 years behind schedule." The deal in question is about seven years old. (CPS began issuing auction-rate debt in 2003.)

Emanuel said he has worked to "right the ship going forward" in part by avoiding those kinds of risky bond deals since taking office in 2011.

"I've told you exactly what I've done, what you can do," Emanuel said. "And in the other places where you can't, unfortunately there's a thing called a contract."

A federal rule requires banks to "deal fairly" with governments when they underwrite government bonds. The Tribune series quoted a former SEC official, Dave Sanchez, saying that "if any part of the bank has concerns that there may be a 'meltdown' and that's not disclosed to the issuer, that would certainly raise questions of fair dealing."

According to a 2009 SEC complaint brought against BofA on behalf of investors, a senior BofA official said in an internal August 2007 discussion that a shortage of cash from banks and investors "could trigger a 'meltdown' " in the market, according to the SEC complaint against BofA.

In the New Jersey case, the state's Higher Education Student Assistance Authority filed a complaint calling the auction-rate market a "sham market." The student loan agency alleges that its underwriter, UBS, fraudulently urged the agency to temporarily change the terms of its contract so there would be no cap on the interest rate, causing $40 million in damages.

Reached for comment, the attorney representing the student loan agency said the issues came to light after the contract was signed.

"After-the-fact information came into their possession that showed that UBS didn't disclose to them material information," said Gregory D. Saputelli, a partner with Obermayer, Rebmann, Maxwell and Hippel.

State regulators also have the ability to take action on behalf of government borrowers. A student loan organization in New Hampshire, won a $20 million settlement in 2010 after the state securities bureau brought an action against its auction-rate underwriter, also UBS.

The Illinois secretary of state's office has taken no such actions. In an interview earlier this year, James Nix, an attorney for the office's securities division, said the division "didn't go into every single possible solution for issuers."

"None of those settlements foreclosed any damages issuers could have pursued on their own," he said.

Brad Miller — an attorney and former congressman who has worked with the Chicago Teachers Union in urging the city to take action on related deals, known as interest-rate swaps — said the New Jersey case "appears generally to be the kind of lawsuit that CPS could bring."

"I don't think CPS needs to show fraud, just that the banks left out information about what could go wrong that might have scared CPS off," Miller said.